THE STOCK sell-off of the past several weeks is no surprise. Newton's Law, the law of averages, the economics of arbitrage and the experience of history all predicted that stocks would fall. Federal Reserve Chairman Alan Greenspan himself had called the event inevitable. Only the timing was uncertain -- a qualifier akin to that old question, "aside from that, Mrs. Lincoln, how was the play?"
But what does it mean? Is the expansion over? Will there be a bear market? Will there be a crash? Will there be a recession? I do not know. Neither does anyone else. But here are four things we do know, or ought to:
First, there is no new paradigm. The "permanent boom" is ending. After seven years of stable growth, we now see many signs of weakness. Purchases have slowed. Earnings and expected profits are down. Growth itself dropped below 2 percent in the second quarter. And unemployment has started to rise.
Second, exports are off -- the predictable consequence of the Asian crisis. The dollar is up, not just against Asia but against virtually every European currency, too, except for the pound. This means imports are cheap -- perfectly predictable bad news for our soaring deficit in trade.
Third, real interest rates are rising. They are up because inflation has continued to fall, while the federal reserve has failed to lower interest rates it controls. Along with declining profits, this discourages new borrowing and business investment.
Fourth, personal debts are high and probably cannot go much higher. Despite some improvement in the past year or two, interest burdens as a share of private income remain near all-time highs. These simple facts tell you that business investment is likely to stall. Exports are unlikely to rise. And, unless personal income rises, personal consumption won't rise either, since households have little leeway to increase their debt. Add to this a falling stock market, and you can read the tea leaves as well as I can.
These signs and symptoms have been around for a while. Why hasn't anything been done?
To begin with, the president and Congress, Democrats and Republicans, have been asleep. They have been dreaming that this expansion would go on forever, that they could spend their time forever wallowing in Starrgate. They may soon wake up; will they have any idea what to do?
Next, the Federal Reserve has been facing the wrong way. Mr. Greenspan's colleagues have been on hair-trigger alert against inflation, which never showed up. The slowdown caught them from behind. Unless the Fed turns quickly, overruling the internal lobby that always favors higher interest rates, Mr. Greenspan's now-stellar reputation is sure to suffer.
And as for the economists, when was the last time my professional colleagues, as a group, correctly anticipated a disaster and recommended action to avert it?
What should be done? First, the Federal Reserve should cut interest rates now, and substantially, to help relieve the Asian crisis, the high dollar and the household debt burden. A sharp rate reduction would also buy time for other measures.
Next, Congress should raise the minimum wage. This would raise personal income where it matters most -- for low-income working people, many of them women.
Finally, the benched giant of our economy, the federal government, needs to get in the game. Almost uniquely in the postwar years, the government has so far played no role in this expansion. Now, a program of new public spending -- on schools, universities, libraries, parks, museums, the environment, transportation, housing and the cities -- is what we need to keep private business humming. With the budget in surplus, why wait until unemployment rises?
To make this possible, we should not cut taxes, especially not on capital gains earned mainly by the rich. (A cut in payroll taxes, on the other hand, might be useful.) We should not abolish the income tax, our great automatic stabilizer, in favor of an unfair consumption tax. We should not privatize Social Security, tying the retirement income of working Americans to an unstable stock market.
No new paradigm
This expansion has been wonderful, both materially and also for the great and pleasant release from economic thought it made possible. It has been fine to imagine a new paradigm, that the stock boom would go on forever, that Alan Greenspan alone could make us rich and keep us rich. It's too bad, but with the beginning of the end in sight, we shall have to start thinking again.
James K. Galbraith, who teaches economics at the University of Texas at Austin, wrote this for Newsday.
Pub Date: 8/17/98